Is It Better to Save or Pay Off Debt?

It’s a question plenty of Americans find themselves asking at one time or another: Should I save more money or focus on paying off my debt? In a perfect world, we could do it all, but from a practical standpoint, discretionary dollars — the money left after paying our living expenses — can be limited. That leaves us needing to make strategic decisions about how we allocate the funds we have.

If you’ve taken out student loans or a car loan, or if you’ve accumulated credit card debt, it may be tempting to make paying off those debts your No. 1 financial priority. While that is a great goal to aim for, you should also be doing your best to save, especially if you haven’t established an emergency fund yet — even $200 to $500 may be a good start before building toward three to six months of expenses. Your long-term financial health depends on developing good saving habits while also responsibly managing your debt.

The answer to the question “Should I save or pay off debt?” is yes. You need to do both, finding the balance that’s right for you. Maybe that means prioritizing paying off your debt, or maybe it means prioritizing saving. The following considerations may help you make that determination and put yourself in a better position in terms of both your finances and your peace of mind.

What To Consider in Balancing Savings and Debt Repayment

Here are some factors to consider as you decide how to allocate discretionary payments to saving versus paying down debt:

Your Emergency Fund

Do you have three to six months’ worth of living expenses tucked away in a savings account in case of an emergency? If not, prioritizing savings and learning how to build an emergency fund may help you achieve this goal. Don’t neglect making at least the minimum payments toward your debt, but commit a set amount to your emergency fund and then meet or exceed that goal every month or every paycheck.

Having an emergency fund is critical in the event you get hit with unexpected expenses — for example, you suddenly need to replace your computer, have your car repaired, or pay for emergency medical care. Having cash on hand for unexpected circumstances can help you avoid borrowing money and incurring potentially costly debt. You might also find that this financial safety net offers you peace of mind.

The Cost of Your Debt 

It’s important to make a list of all of your debt and make sure you understand what interest rate you are paying to carry that debt. While experts disagree as to what constitutes a “high” interest rate, if you look at your most recent statements, you can see how much your debt is costing you each month. If the amount you are paying to carry the debt exceeds the amount you could potentially earn by saving the money instead, then there is a practical case for prioritizing debt repayment.

You may want to target paying off the account(s) with the highest interest rate(s) first, to reduce the amount of interest you are paying. This is called the “avalanche” method. You make larger payments to that account while continuing to make the minimum payments on your other accounts and putting some money into savings. Once that account is paid, you can move to the account with the next-highest interest rate, and continue until your debts are repaid.

Alternatively, some people prefer to target their smallest balance first so they can feel a sense of achievement by paying off a balance quickly and then moving on to the next smallest balance, and so on. This is called the “snowball” method, which may help you stay motivated even if it doesn’t save as much in interest.

Your Employer’s 401(k) Match Program, if Offered

If your employer offers a retirement plan that matches funds to a certain percentage (on average, 3% to 6% of your salary), that is essentially free money you can earn simply by contributing to your account. This is a case for prioritizing saving, and it's important to consider how much you should contribute to your 401(k). As long as it will not prevent you from paying your living expenses or meeting other financial obligations, do your best to contribute at least enough to get the maximum employer match.

There’s another reason to make sure you are saving for retirement today. The compound interest earned in a retirement plan helps it grow over time. If you wait to contribute to your retirement plan until you are debt-free, you will have lost precious time during which your money could have grown.

Your Short-term Savings Goals 

Saving for emergencies and retirement are probably not your only savings needs. Maybe you are planning to buy a car in the next few years, or you want to do some traveling next summer. Figure out how much money you will need to have saved to achieve each of these goals and then dedicate some of your discretionary income to these short-term goals as well.

Tips for Saving Money

Saving money doesn’t have to be overwhelming. With a few simple steps, you may be able to build momentum and gradually set yourself up for long-term financial security. Here are some strategies to consider:

• Start with an emergency fund. Even if you can only set aside $25 or $50 a month, consistency matters. Aim first for a small cushion, then build toward three to six months of essential expenses.
• Choose the right savings account.Shop around for a savings account with an interest rate that will help your money grow faster.
• Take advantage of retirement benefits. If your employer offers a match on retirement contributions, contribute at least enough to get the full match. This is essentially free money toward your future.
• Automate your deposits. If you set up automatic deposits into your savings account from each paycheck, you will be “paying yourself first.” If you never have the money in hand, you aren’t tempted to spend it; instead, it goes directly into your savings account.
• Set up separate savings buckets for specific goals. You might have one account for vacations, another for a car down payment, and another for emergencies. Many banks allow multiple savings subaccounts to keep goals organized.

Tips for Paying Down Debt

Managing debt is easier when you have a clear plan. By staying organized and consistent, you may make steady progress toward repayment. Here are some practical tips to keep in mind:

• Make at least the minimum payment to each account on time every month. Even if you choose to prioritize saving, you must make good on your commitment to repay loans and credit card debt by making on-time payments. Late or missed payments may result in fees, additional interest charges, and damage to your credit score.
• Use a repayment strategy. The avalanche method targets high-interest debts first to save money over time, while the snowball method targets small balances first to build momentum. Choose the one that motivates you most.
• Review your budget. Look at your spending to identify areas where you can cut back. Redirect any freed-up money toward debt payments.
• Consider debt consolidation. If you have good credit, you might qualify for a balance transfer card with a 0% promotional APR or a debt consolidation loan or a Home Equity Line of Credit at a lower interest rate. These may help simplify repayment and save on interest.
• Automate payments. Setting up autopay ensures you never miss a due date and can help you stay consistent with your repayment plan.

Finding Your Financial Balance

There isn’t a one-size-fits-all answer to whether saving or paying off debt should come first. The key is striking a balance that fits your situation — protecting yourself with an emergency fund, taking advantage of savings opportunities, and steadily paying down what you owe. Taken together, these steps may help create financial stability today while laying the groundwork for a stronger future.